Financial Instruments

Question 1

Need for accounting standards

Answer 1

• Increasingly complex ways of raising finance
• Problems with derivatves such as fowards, futures, swaps etc
• Unrealised gains/losses on many financial instruments were not recognised
• Companies could choose when to recognise profits in order to smooth profits

Question 2

What is a financial instrument

Answer 2

Any contract that gives rise to a financial asset of one entity and a financial liability of another entity

Question 3

IAS 32/39 /IFRS 7

Answer 3

The standard catagorises assets / liabilities as:
- held for trading
- held to maturity
- loans and recievables
- available for sale
Available for sale and held for trading measured at fair value
Loans and recievables and held to maturity measured at amortised costs using the effective interest method
Any financial asset that does not habe a quoted market price in an active market and whose fair value cannot be relaibely measured is valued at ammortised cost

Question 4

What is a financial asset?

Answer 4

Any asset that is:
- cash
- An equity instrument of another entity
- A contractual right to recieve cash or another financial asset from another entity
- A dontractual riht to exchange financial assets or financial liabilities under conditions that are potentialluy favourable to the entity

Question 5

What is a financial liability?

Answer 5

A contractual obligation to deliver cash or another financial asset to another entity
A contractual obligation to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity

Question 6

What is held for trading?

Answer 6

These are assets intended to generate a profit fro short-term price fluctuations
These assets measured at fair value on the SoFP with gains and losses being posted through te income statement
Exanples:
- Ordinary shares
- Iredeemable prefernce shares
- Bonds
- Derivative contracts

Question 7

What is helf to maturity?

Answer 7

These are asstes iwth fixed or determinable payments and fixed maturity that the company intends to hold to maturity, irrespective of changes in market prices or the company’s positions
Prices for these assets must be quoted in an active market
Examples
- Redeemable preference shares
- Bonds
- Forward Contracts

Question 8

Loans and recievables

Answer 8

These assets have fixed or determinable payments
They are not quoted in an active market
Meeasured at ammortised cost
These assets are valued at ammortisedd cost in SoFP
Examples:
- Loans
- Mortgages

Question 9

What are equity instruments?

Answer 9

• ANy contraxt that evidences a residual interest in the assets of an entity after deducting all its liabilities
• No contractual obligation to deliver cash or another financial asset to another entity
  Example:
• Holders of ordinary hsraes in a company own equity instruments

Question 10

Preference shares and equity/liability

Answer 10

If prefernce shares are irredeemable it is equity
If it is redeemable it is a financial liability

Question 11

Initial Recognition

Answer 11

Recognise a financial asset or financial liability when the company becomes a party
Initially recognise at the fair value plus any directly attributed transaction costs

Question 12

What are directly attributable costs?

Answer 12

Those costs that are specific to he instrument, and would have been avoided if the instrument had not been issued e.g.
- legal fees
-stamp duty
- printing costs
costs that are not directly attributable are charged as an expense when incurred e.g.
- Research into financing options
- Costs of an abandoned issue
- Manegement Salaries

Question 13

How are financial asses initially recorded?

Answer 13

• at cost plus (deducing directly attributable costs)

Question 14

What are finance costs?

Answer 14

The difference between net porceeds of an instrument and the total amount of the paymnets (or other transfers of economic benfiits) that the issuer may be required to make

Question 15

Compound financial instruments

Answer 15

Instrumnets that have both liabolity and equity component
e.g. convertible bonds
The fair value of the financila liability is calculated first at the equity instrument is te difference between total proveeds and fair value of financial liabiliy

Question 16

Inclusion in financial statements

Answer 16

Interest and dividends relating to a financial liability should be
recognised in the profit and loss account as an expense.

• Dividends on preference share classified as a liability may be shown
  separately
• Distributions to holders of equity interest should be debited directly
  to equity.

Question 17

Subsequent measurement

Answer 17

Classification determines

• Value in balance sheet
  – Amortised cost
  – Fair value
• Where gains or losses are recognised
  – Income statement
  – Equity

Question 18

Ammortised cost

Answer 18

Amortised cost is the cost of an asset or
liability adjusted to achieve a constant
effective interest rate over the life of the
asset or liability.

Question 19

Fair value

Answer 19

The amount for which an asset could be
exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length
transaction.

Examples of methods:
– Published market prices
– Transactions in similar instruments
– Discounted future cash flows
– Valuation models

Question 20

Imapirments

Answer 20

At each financial year end companies are required to
assess whether financial assets need to be impaired

• This requires consideration as to whether there is likely to
  be an impact on estimated future cash flows of the asset
• Recognise impairment loss in profit and loss account

Question 21

Derecognition

Answer 21

Derecognise financial assets when the risks and
rewards that comprise the asset are transferred.
– Benefits are realised
– Rights expired
– Benefits surrendered

• Derecognise financial liabilities when the
  obligation specified in the contract is discharged
  or cancelled.

Question 22

Disclosure

Answer 22

The objective of IFRS 7 and IAS 32 disclosures is to provide sufficient
information so users can evaluate:
– the significance of on balance sheet and off balance sheet financial instruments on an
enterprise’s financial position, performance and cash flows
– the risk management policies of the organisation
– the of terms, conditions and accounting policies in relation to all financial assets,
financial liabilities and equity
– the exposure to interest rate risk and credit risk in all financial assets and financial
liabilities
– information on fair values e.g. method used to determine fair value

• Practical matters to be disclosed:
  – classification of the financial instrument (using substance over form)
  – separate classification of component parts of the financial instrument in equity and
  liabilities (convertible debt)
  – reporting of interest, dividends, losses and gains from a financial instrument

Question 23

FRS 9 Financial Instruments

Answer 23

The Standard includes requirements for recognition and
measurement, impairment and derecognition

IFRS9 classifies financial assets into:
– financial assets at amortised cost
– financial assets at fair value though OCI
– financial assets at fair value through profit or loss

• Designation at fair value through profit or loss can still be used if this
  significantly reduces an accounting mismatch
• Only one impairment method available – assets at amortised cost

Question 24

Reasons for revision to stamdards

Answer 24

o Standards were most difficult and controversial for the IASB to issue.
o Drawn from USGAAP and have been criticised for being too rules based.
o They have had political implications
o Blamed as contributing to the banking crisis in October 2008
o IAS 39 was amended without going through the normal due process.

Question 25

Difficulties of IAS 18

Answer 25

• Lack of guidance to measure the elements in a multiple-element arrangement
• Without a specified measurement objective for the remaining elements in such an arrangement, entities apply different measurement approaches to similar transactions, which reduces the comparability of revenue across entities.
• No clear distinction between good and services